Wriston, Walter B.
So far as I know, history does not record the name of the person who first planted a stick in the ground and related the length of the shadow it cast with the time of day. The first crude gnomon was refined over the years and sundials were calibrated to show the hours. Eventually the measurement of time progressed from water clocks all the way to atomic clocks. Man's desire to measure time accurately has now reached the point where a ten-dollar quartz watch is more accurate than the most expensive timepiece that could be produced only a few years ago. Technology made the difference.
Skilled old craftsmen in the watch trade did not greet the advent of quartz technology with any great enthusiasm. The reigning experts knew that the way to build clocks was with levers and gears and not with silicon chips. This is not an unusual reaction to change, especially if it appears to threaten one's livelihood. While we still see sundials in the quiet gardens of the world, we order our lives with more exact timepieces.
The desire to measure things is a continuing phenomenon that runs the gamut from the quart of milk in the supermarket to detailed public opinion polls on every conceivable subject. The best of the public opinion polls have been quite accurate in predicting elections, and while there have been misses here and there, on balance the record is fairly good. The best practitioners of this new art have learned to frame the question and interpret the answer to produce the best forecast.
The train of thought we all go through in the reasoning process is reflected in the words we use to describe the scene as we see it. While it's an ancient question whether or not we can think through a problem without using words, if we accept the thesis that words are at the very least helpful, then the meaning of those words becomes crucial in arriving at a good answer. Today I would argue that the words we use to describe and measure our economy no longer accurately reflect our society as it exists today.
Even very good people using bad information misjudge the situation. Since some very excellent economists have been dead wrong in their judgments about the future of the American economy, perhaps a case can be made that their mistakes may have flowed from using words and concepts that are no longer applicable to the real world. Most of the terms we use in standard economic analysis were invented in the industrial age, and while many are still relevant, some no longer measure what they once did because the base has changed.
George Stigler, the Nobel laureate who has done such brilliant work on the consequence of economic policies put it this way:
In order to get that information, we must have ways to measure things in some impartial manner. One of the principal sets of measures is published by our government. When George Jaszi retired recently, he left behind him the framework of the National Income and Products Accounts, which was first constructed in the midst of the Great Depression. The common wisdom about the American economy then was expressed by Franklin Roosevelt who stated, "Our industrial plant is built...Our task now is not discovery or exploitation of natural resources, or necessarily producing more goods...it is the soberer, less dramatic business of administering resources and plants already in hand..." At that time our GNP was about 56 billion dollars and our exports less than 500 million dollars. The desire to regain the high-employment levels of the late 1920's quite naturally affected the interpretation of the numbers. By any reckoning, the measurement of the GNP is an immensely difficult task, but today a case can be made that too much reliance on any single measure or concept of National Income Accounts puts one in real danger of missing one's economic forecasts. And what's far worse--bad economic policy.
It is no secret that in the last few years many very intelligent and skilled economists have badly missed predicting the direction of the U.S. economy. The puzzle is why. One reason may be that the measures we use in the National Income Accounts may no longer calibrate our society as accurately as they once did because our world has changed so dramatically since they were formulated. This is a suggestion that may be greeted by economic practitioners with all the joy that watchmakers bestowed on the silicon chip.
Despite these hazards, it may be worthwhile to look more carefully at a few of the measuring sticks. First, the National Income Accounts don't have the same relevance they once had because they are strictly national in scope, although we now live in a global economy tied tightly together by telecommunications. Economic or political isolation is a thing of the past. The two wide oceans that were real barriers in George Washington's time can no longer perform this function. Data and voice transmissions now move with the speed of light via satellite and cable across the oceans, while ICBM's can bridge these bodies of water in minutes. This reality of one world that Wendell Willkie wrote about in the 1940's, but never lived to see, is one of the central realities of our time.
What goes on in the world around us does not loom large in the numbers produced by national income accounts for the simple reason that they were not designed to capture it. At one time that was appropriate. Today, however, the global marketplace has moved from rhetoric to reality. Money and ideas can and do move to any place on this planet in seconds, and there is no longer any place to hide from the judgments of others. Bad economic policy in one nation is instantly known and reflected in the foreign exchange markets of the world. Major economic or political events anywhere in the world affect our economy directly or indirectly. While this may seem self-evident, it is often not automatically a part of our reasoning process. In 1972, for example, when U.S. imports as a percent of GNP were only about a half as large as today, many forecasters underestimated the sharp increase of inflation that followed in the wake of the dollar devaluation because they failed to appreciate the close interconnection. It makes as little sense today to look at the GNP of the United States without reference to the rest of the world, as it would to analyze the GNP of New York State without looking at the rest of the country. The Netherlands, with a population about the size of New York State, has its own GNP accounts, even though sensible policy analyses must proceed by looking at the rest of Europe as well. The deficits of European nations affect the American and other economies in a way not unlike our own deficit, since the money markets of the world are linked together electronically. In this connection, we should keep in mind that our deficit in the budgets of local, state, and federal governments combined is smaller, as a percentage of GNP, than all but one of our trading partners attending the Economic Summit.
The failure to understand the reality of the global market helps explain why the crowding-out theory was never validated. People added up all the capital instruments sold on Wall Street in a year, and then took the amount of Federal debt sold and computed a ratio that purported to say that the Federal Government absorbed 20%, or whatever the number, of all capital raised. That ratio may once have been useful, but today it is a matter of complete indifference to the chief financial officer of any major company whether one sells capital notes in New York, Hong Kong, or London. The market is not confined to Wall Street--it is the world. With the world's savings flowing across borders, National Accounts no longer give as accurate view of the economy as they once may have. The failure to understand this massive change has caused more than a few economic forecasts to go awry.
Let me shift, for a time, from GNP to the notion of overall productive capacity, a concept that plays an important role in the formulation of monetary policy. Some economists reason that if industrial production is at, say 85% of capacity, we are approaching the physical limits of output and thus we are in danger of starting up inflation. What these words do not tell you is that industrial production in the year 1985 employs only about 20% of American labor and that there is an almost infinite capacity to expand in the other non-industrial sectors of our society. This was not always the case. The words we use are the words and reasoning we used when the majority of our labor force was employed in the industrial sector. These shifts of employment have been part of the American scene since our country started. Our farm population, for example, once constituted three-quarters of our working population. Even at the beginning of this century, more than one-third of us were farmers. When the last world war started, close to a quarter of our population lived on a farm. Today farmers constitute about 3% of our workers, but their productive capacity is the wonder of the world.
A not dissimilar phenomenon is taking place in industrial production. The proportion of workers employed declined, but if we look at the volume of production, there has been almost no shift of consequence. In 1960, the output of goods accounted for about 45% of GNP and it still remains in that range.
This relatively steady output, in the face of a massive exodus of workers from industry, raises the question of whether the figures on percentage of industrial capacity utilized mean the same thing for inflation as they once did. Indeed, this measure of capacity utilization played a key role in leading some forecasters to overestimate inflation in this current economic expansion. Another reason that the capacity utilization index is misleading is that it covers only manufacturing, mining and utilities, activities which account for a shrinking share of U.S. output. If it turns out that the ratio does not mean the same thing that it used to, the question then becomes--can we construct a new more reliable measure for the kind of economy we now have?
Another word that is much in the news is productivity. How does America stack up in the global marketplace? Is the growth of American productivity greater or less than that of Japan or some other nation? These are important questions, but once again what do the words mean? When we talk about productivity, it used to mean in its crudest terms, output per man hour. While that is a useful concept in manufacturing, do we really have any meaningful measure of productivity in the information intensive age when the vast majority of our workers are employed in the service sector? The huge financial service industry is one example of the difficulty of measuring productivity. Once we get past counting the number of checks cleared per hour, or the number of insurance claims paid--all of which display greatly improved productivity, thanks to the computer--we then move immediately into the realm of the subjective. Is a loan officer's productivity in a bank or insurance company or a credit company to be judged on the number of loans made, the size of the loans, the number of loans that are repaid on time, the quantity of bad debts created, or how do you measure productivity? No one really knows, even though many have tried. Although much work has been done in measuring productivity in steel and autos, industries which now employ less than two percent of our labor force, enough work may not have been done in other areas to give us great confidence in the productivity numbers.
Even in automobiles much has changed that the numbers do not capture. The cost of externalities has become a bigger factor. As Juanita Kreps has said:
If we think about our economy, another word we use is capital. Economists of many schools tend to agree that capital is stored-up labor which has been expressed in dollars. A good case can now be made that knowledge and information are becoming the new capital in today's world. To suggest we examine this possibility does not mean the end of money capital, but it may throw a different light on the problem, so much discussed, of capital formation. To enter a business the entrepreneur in the information age needs access to knowledge more than he or she needs large sums of money. To write the software program that may make the author millions of dollars may require only a relatively trivial sum of money, as compared to the amounts of money we used to think of as capital in entering, say, a heavy manufacturing business. On the other side of the coin, the knowledge capital accumulated in the software writer's head, or in the documentation, or on disks, is very substantial and very real. A strong argument can be made that information capital is as important, or even more critical, to the future growth of the American economy than money. Despite this perception, this intellectual capital does not show up in the numbers economists customarily look at or quote about capital formation.
If capital is what produces a stream of income--and that's a definition no one seems to quarrel with--then it follows that knowledge is a form of capital. And what's clear is that the formation of new knowledge is growing apace. Today it is accurate to say that at least 80: of all the scientists who ever lived are now alive, and that in our own country at least half of all scientific research done since the Revolution has been conducted in the last decade. With the total stock of knowledge doubling about every ten years, it is clear that our intellectual capital is being formed far more rapidly than tangible capital.
Even the numbers we use to describe tangible capital investment have some problems. Sometimes the figures may show that we are "disinvesting" when, in fact, what we are really doing is paying less money for much more capacity. We see this in our own lives in the ratio of price to capacity in the hand-held calculator, or the watch on your wrist, or the home computer on you desk. In saying that, I am not arguing that money capital will not continue to be very important; it will. But I am suggesting that the amazing accumulation of knowledge capital in the last twenty years is very substantial and growing every day but it is uncounted. We have little or no control over the natural resources within our borders, but we do have control over our educational and cultural environment that produces the men and women who have led, and will continue to lead the world. If we want better economic forecasting and better policies, clearly some way needs to be found to crank the growth of knowledge into our equations.
In suggesting that it may be time to take a new look at many of the measures we use in assessing the economy, I am aware that almost every number we use has its constituency. Many labor contracts are tied to one inflation index or another, and shifting the content or the ratio of goods in the market basket would impact many people. The National Income Accounts, as presently constituted, are used by people in business and any change in them might be upsetting, but, nevertheless, I believe that things really have changed.
A new world may require a new look at the way we calculate GNP since today's method not only fails--except indirectly--to capture the benefits of rapidly accumulating knowledge, but it's also marred by inconsistencies. For example, income is imputed to the owners of homes that they occupy, but there are no imputations for streams of services--real income, if you will--that emanates from autos, dishwashers and other consumers' durables. In times of high taxation, durables--which are arguably capital investments--provide shelter, not only from taxes but often from the ravages of inflation. And there are other problems with GNP accounting, such as the overstatement of output that results from the treatment of capital consumption. If such conceptual omissions and errors affected only the accuracy of economic forecasts, there would not be so great a cause for concern. But that's not the case. GNP and productive capacity measures play a critical role in the formulation of the Federal Reserve's monetary policy.
What rightly concerns Fed policymakers is how fast the real economy can grow over the long haul without heating up inflation. Or to put it in the vernacular, what's the real potential growth rate for real GNP? The Fed, as nearly as I can infer from public statements, assumes GNP potential of around 3 percent while some of their supply-side critics insist that it's as high as 5 percent. And since the difference between a 3 and 5 percent potential could mean a huge difference in the level of real GNP over a 10-year span, the issue is anything but trivial.
Since the concept of potential GNP leans heavily on physical capital alone and productivity increases in the out years, it may be a dim star to steer by in today's world.
If knowledge capital is becoming relatively more important, we may be seeing a shift from an energy intensive and materials intensive economy to an information intensive society. The current vocabulary of economics describes a world that still exists in part, but it may fail to capture the essential measures in this new world. My colleague, John Reed, invented the term in Citicorp of "investment spending," a concept it took us some time to understand as it seemed, at first glance, to be a contradiction in terms. But it was and is appropriate to our times. Peter Drucker has said: "Indeed, in an information-based economy much of what we now consider 'expenditure' or 'social overhead' is actually 'capital investment', and should--perhaps, must--produce a high return and be self-financing."
In suggesting we rethink and relook at the shifting pattern of the elements which make up our economy, we are only taking a leaf out of the political book of the world.
We no longer look at maps published before 1931 when the Statute of Westminster was passed that gave formal recognition to the autonomy of the dominions of the British Empire. While the globe itself has not changed in an overall sense, the lines on the map of the world have been redrawn and dozens of new countries have been created. It would be folly to conduct our foreign policy based on the geopolitical map of 1930. It may be that conducting part of our economic policy based on measures that were valid in the thirties carries similar hazards for us now.